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Double-Dip Recession: Previous Experience and Current Prospect

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Double-Dip Recession: Previous Experience and Current Prospect Double-Dip Recession: Previous Experience and Current Prospect Craig K. Elwell Specialist in Macroeconomic Policy June 19, 2012 Congressional Research Service 7-5700 www.crs.gov R41444 CRS Report for Congress Prepared for Members and Committees of Congress Double-Dip Recession: Previous Experience and Current Prospect Summary Concerns have been expressed that growth in the United States may falter to the point where the U.S. economy again experiences recession. A double-dip or W-shaped recession occurs when the economy emerges from a recession, has a short period of growth, but then, still well short of a full recovery, falls back into recession. This prospect raises policy questions about the current level of economic stimulus and whether added stimulus may be needed. The pace of the recovery has been relatively slow and growth has recently decelerated. For the first year of the recovery, real GDP grew at an average rate of 3.3%, slow by the standard of earlier post-war recoveries, but fast enough to stop the rise of the unemployment rate at 10.1% in October 2010 and to cause it to fall to 9.5% by mid-2010. In the recovery’s second year, the rate of GDP growth slowed to an average rate of 1.6%, and the unemployment rate was only slightly lower at 9.1% by mid-2011. Growth remained weak during the recovery’s third year, advancing at an annual rate of 1.9%, and the unemployment rate had only improved to 8.2% by May 2012. Other indicators, such as weak consumer spending, falling house prices, reduced flows of credit, the prospect of fading fiscal stimulus, and the premature return of recession in the euro area are also worrisome. Double-dip recessions are rare. There are only two modern examples of a double-dip recession for the United States: the recession of 1937-1938 and the recession of 1981-1982. They both had the common attribute of resulting from a change in economic policy. In the first case, recession was an unintended consequence of the policy change; in the second case, recession was an intended consequence. Historically, there has been what is termed a “snap back” relationship between the severity of the recession and the strength of the subsequent recovery. In other words, a sharp contraction followed by a robust recovery traces out a V-shaped pattern of growth. However, unlike earlier post-war recessions, the recent recession occurred with a financial crisis. Research suggests that a slow recovery with sustained high unemployment is the norm in the aftermath of a deep financial crisis. The prelude to the economic crisis in the United States was characterized by excessive leverage (the use of debt to support spending) in households and financial institutions, generating an asset price bubble that eventually collapsed and left balance sheets severely damaged. The aftermath is likely to be a period of resetting asset values, deleveraging, and repairing balance sheets. This correction results in higher saving, weakened domestic demand, a slower than normal recovery, and persistent high unemployment, but not necessarily a double-dip recession. Slower growth in the first half of 2011 was, in part, attributable to temporary factors, such as supply chain disruptions caused by the earthquake in Japan, recent floods and tornadoes in the South and Midwest, and the spike in many commodity prices, particularly oil. Nevertheless, recent economic indicators suggest that the recovery’s underlying momentum has also weakened. While not leading to projections of a double-dip recession, this weakening has prompted many economic forecasters to substantially reduce their near-term growth projections from those made in 2011. This report discusses factors suggesting an increased risk of a double-dip recession. It also discusses other factors that suggest economic recovery will continue. It presents the U.S. historical experience with double-dip recessions. It examines the role of deleveraging by households and businesses in the aftermath of the recent financial crisis in shaping the likely pace of economic recovery. The report concludes with a look at current economic projections. Congressional Research Service Double-Dip Recession: Previous Experience and Current Prospect Contents Background...................................................................................................................................... 1 Factors That Suggest Increased Risk of Double-Dip Recession...................................................... 2 Indicators of Continued Economic Weakness ........................................................................... 2 Possible Negative Economic Shocks......................................................................................... 3 Historical Experiences with Double–Dip Recession ....................................................................... 4 The 1937-1938 Recession: A Premature Removal of Economic Stimulus ............................... 5 The 1981-1982 Recession: A Policy of Disinflation ................................................................. 6 The Pattern of Past and Present Economic Recoveries ................................................................... 6 The Impact of a Financial Crisis on the Pace of the Subsequent Recovery .............................. 7 The Drag of Deleveraging on U.S. Economic Growth.............................................................. 8 More Support from the Foreign Sector?.................................................................................... 9 Economic Policy Response ....................................................................................................... 9 Economic Projections .................................................................................................................... 10 Contacts Author Contact Information........................................................................................................... 11 Congressional Research Service Double-Dip Recession: Previous Experience and Current Prospect Background Recent economic fragility in Europe is again prompting concern that the United States may be about to experience a “double-dip” recession. A double-dip or W-shaped recession occurs when the economy emerges from a recession, has a period of growth, but then falls back into recession, well short of a full economic recovery. This prospect raises policy questions about the current level of economic stimulus and whether added stimulus may be needed. The 2007-2009 recession was long and deep, and according to several indicators was the most severe economic contraction since the 1930s (but still much less severe than the Great Depression). The slowdown of economic activity was moderate through the first half of 2008, but at that point the weakening economy was overtaken by a major financial crisis that would exacerbate the economic weakness and accelerate the decline.1 When the fall of economic activity finally bottomed out in the second half of 2009, real (i.e., inflation adjusted) gross domestic product (GDP) had contracted by approximately 5.1%, or by about $680 billion.2 At this point the output gap—the difference between what the economy could produce and what it actually produced—widened to 8.1%.3 The decline in economic activity was much sharper than in the nine previous post-war recessions, in which the fall of real GDP averaged about 2.0% and the output gap increased on average to near 4.0%. The economy, as measured by real GDP growth, began to recover in mid-2009. However, over the next three years, the pace of growth has been slow and uneven. During 2009 and 2010, growth had been largely sustained by transitory factors, such as fiscal stimulus and the rebuilding of inventories by business. In the first half of 2010, economic growth showed signs of beginning to be generated by more sustainable forces such as consumer spending, business investment spending, and exports. But the strength of those forces continued to be uneven, and they weakened by the year’s end. In the first quarter of 2011, growth slowed sharply to a 0.4% annual rate, largely because of a deceleration of consumer and government spending. This pronounced slowing of growth raised concern about the recovery’s sustainability and the prospect of a second “dip” into recession. However, over the remainder of 2011 the pace of economic growth improved. Propelled by stronger business investment spending and a positive contribution from net exports, the pace of growth increased to a 3.0% annual rate in the fourth quarter of 2011, allaying concern about the return of recession. In the first quarter of 2012 growth slowed again, falling to a 1.9% annual pace. Growth at less than a 2% annual rate may not be fast enough to close the output gap or to keep the unemployment rate from rising.4 Moreover, the persistence of economic weakness in the United States, the prospect of negative spillovers here from Europe’s return to recession, and a looming 1 See CRS Report R40007, Financial Market Turmoil and U.S. Macroeconomic Performance, by Craig K. Elwell. 2 Real GDP is the total output, adjusted for inflation, of goods and services produced in the United States in a given year. GDP data are available from the Bureau of Economic Analysis, U.S. Department of Commerce, at http://www.bea.gov/. 3 Computation made from data on GDP and potential GDP available at FRED Economic Data, Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/categories/106. 4 U.S. Department of Commerce, Bureau of Economic
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